While cryptocurrency investing might seem like the next best thing, and it is, there has to be a catch. The catch here is that your earnings aren’t just yours. You have to pay taxes on them just like in the traditional investment market. This must be done based on each individual trade, and, of course, the price in which each trade was made.
If that sounds tedious, that’s because it is. Even worse, if you don’t accurately keep track of this information, you can and will be punished for tax fraud.
Fortunately, there are ways to track and file your cryptocurrency purchases and taxes that greatly streamlined the process. In this guide, we’re going to go over just that.
In This Article:
- Do I Have to Pay Taxes on Cryptocurrency?
- Detailing Taxes on Cryptocurrency
- Why You Must Pay Cryptocurrency Taxes
- Hard Forks, Airdrops, and Other Unique Cryptocurrency Cases
- How to Pay Taxes on Bitcoin and Other Cryptocurrencies
- The Best Crypto Tax Software to Help You Pay Taxes on Crypto
Do I Have to Pay Taxes on Cryptocurrency?
The short answer is yes, you do have to pay taxes on cryptocurrency. The long answer is that the Internal Revenue Service (IRS) treats cryptocurrencies as property, despite them recognizing it as a tradeable, digital currency with varying value. It isn’t treated as a currency in the eyes of the IRS.
The act of selling your cryptocurrency to convert into fiat is taxable. Converting one cryptocurrency to another, like Bitcoin to Ethereum, is taxable. Making a payment with cryptocurrency is a taxable event. This could be anything from rent to salaries paid in these digital currencies. Yes, that means if you’re an employer or an employee who pays or receives payment in cryptocurrency, you must pay a tax on that event. Also, if you attempt to use Bitcoin or other cryptocurrency in a traditional way. Buying groceries is a taxable event, for example.
However, not every cryptocurrency transaction is taxable. For instance, transferring cryptocurrency between wallets or exchanges is not taxable, though you will likely pay some transaction fees to different exchanges. Also, purchasing an asset with fiat isn’t taxable – only if you do something with it.
This can all appear tedious to keep track of, though there is software that can assist you, which we’ll go over later in this post.
Detailing Taxes on Cryptocurrency
As stated previously, the IRS classifies cryptocurrencies as property. Traders are to pay income tax on their holdings, be it gains or losses. This means that to pay taxes on cryptocurrency, one must track the price at which the asset was purchased. Of course, day trading cryptocurrency taxes are a little different. If you day trade, you must keep trade of all of these prices and when you sold or converted assets as well. Losses, of course, can be written off.
Then we have something called short-term or long-term gains. Short-term gains are when you hold an asset for less than a year or sell it for a profit. However, holding cryptocurrency for longer than a year makes it a long-term gain. These result in lower tax rates for a trader, meaning those who hold will pay less to the government overall, and can very from a 15% to 20% tax. But regardless, unlike those who hold assets for less than a year, those who hold for over 365 days must pay capital gains tax on that cryptocurrency. This is declared on Form 8949 to the IRS.
Mining and staking cryptocurrency is a whole other beast. Those who mine should know that rewards are technically classified as income. It’s important to note down the exact value the asset is released and put into your wallet. Staking is the same process. Then, if you trade or sell that mined cryptocurrency, it falls under the capital gains and losses tax rules. Of course, mining as a business means reporting it as business income, while hobby mining is considered “other income.”
Users into decentralized finance must also pay taxes. If you receive a cryptocurrency loan, profit from interest on providing a loan in cryptocurrency, or something similar, you must also pay an income tax on it. However, it’s important to distinguish that this is only if you do this with cryptocurrency as the main form of transaction. If you take a loan against your cryptocurrency, this isn’t taxable. Interest, of course, must be paid, but there’s no form of capital gains tax.
FIFO and LIFO
There are two main ways to track your cryptocurrency taxes: FIFO and LIFO. FIFO stands for First In First Out, meaning that you should sell the first asset you bought. From here, you can look at the amount this asset was at purchase, and subtract that number from the price you sold it at, making it easy to figure out your capital gains on Bitcoin and other cryptocurrency.
LIFO, which stands for Last In First Out, works similarly. This means you sell the last asset you bought first, and subtract the selling price from what you just bought. This can help you keep track of any losses made.
Why You Must Pay Cryptocurrency Taxes
You may think that because of the anonymous nature of cryptocurrencies, you can get away with avoiding paying taxes on cryptocurrency. This is absolutely not the case. After all, some cryptocurrency exchanges in the United States, like Coinbase, are required to report to the IRS regarding their cryptocurrency purchases for traders who have transacted over $20,000 in one go. They’re likely going to extend this to everyone over time – not just big profiteers.
On top of this, even if the exchange didn’t report you, blockchain networks aren’t as anonymous as one may think. Bitcoin’s network, for example, is a public ledger. It’s not impossible for experts to track an address and figure out the identity behind it.
Keep in mind that the IRS has also sent letters to a variety of cryptocurrency taxpayers, asking them to pay back taxes on assets they didn’t report in the past. They’re not stupid, and chances are they will find evaders. According to CNBC, you can go to prison and be fined up to $250,000 for not paying taxes on your cryptocurrency transactions.
Hard Forks, Airdrops, and Other Unique Cryptocurrency Cases
While the IRS Bitcoin and IRS cryptocurrency tax rules have been in place since 2014, it wasn’t until 2019 that the group said anything about airdrops and hard forks. Fortunately, it doesn’t add too much confusion.
It has been classified that hard forks that don’t provide airdrops aren’t necessarily a gross income, meaning that they are not taxable events. However, hard forks with airdrops are another story. These scenarios mean that wealth was created, and traders must pay income tax on the fair market value at the time of the airdrop since an asset with value was essentially created at that time.
How to Pay Taxes on Bitcoin and Other Cryptocurrencies
To streamline the process, the IRS has made it so paying taxes on Bitcoin and other cryptocurrency is actually built into the Form 1040, under the additional income and adjustments to income sections. This was put into place for the 2019 taxpaying season, and reads: “At any time during 2019, did you receive, sell, send, exchange or otherwise acquire any financial interest in any virtual currency?”
That said, this doesn’t exactly make things clear, as you need to report the numbers somewhere else – on the W-2 form. Fortunately, the previously mentioned crypto tax software can help you do this.
The Best Crypto Tax Software to Help You Pay Taxes on Crypto
Unfortunately, while they’re great for trading, buying, and selling cryptocurrency, exchanges aren’t great at helping your report your taxes on Bitcoin or other cryptocurrencies. This is where cryptocurrency tax software comes into play.
Cryptocurrency tax software helps you import your transactions for the year, and assists you in generating reports for your transactions such as buy and sell prices.
The best crypto tax software comes with transaction importing, automatic report generation, and allows for a reasonable amount of transactions.
CryptoTrader.tax is one of the more simplistic cryptocurrency tax software on this list, and that isn’t a knock on it. An easy to use software with a streamlined interface, CryptoTrader.tax ensures you can pay a Bitcoin tax with little to no effort required.
To use it, an API simply imports your trade history from exchanges like Coinbase or Binance. Or, you can import your CSV from other exchanges. From here, you’ll have to manually add in any mining income or cryptocurrency gifts.
Once done, CryptoTrader.tax will create a tax report and break it up into documents like an audit trail report, a cryptocurrency income report, a short & long term sales report, and more. Any document you need, this software should provide, as it supports FIFO, LIFO, and HIFO as well.
Finally, when filing your taxes, you can simply import the information into something like TurboTax, or even send it to your accountant or someone else doing your taxes. From there, your cryptocurrency taxes are done.
It’s also worth noting that the platform’s pricing only starts at $49 per season, meaning it’s quite affordable for anyone needing the software. However, that plan only handles up to 100 trades. If you’re more of a day trader and need to track up to 1,500 or even 5,000 trades, you’ll need to jump up to the $99 or the $199 per season plans, respectively.
Developed by cryptocurrency tax attorneys and top blockchain CPAs, this cryptocurrency tax software is compatible with over 100 cryptocurrency exchanges. It’s compliant with the United States tax code regarding cryptocurrency, provides audit trails and analytics, and provides support for over 4,200 cryptocurrencies.
If you’re a frequent trader of altcoins, this is the software for you. Not only does it provide the forms you need to report your taxes, but it also gives you detailed metrics for your portfolio, as well as history and performance, allowing you to make more accurate trades based on your history. Plus, TaxBit allows you to integrate you wallets as well as your exchanges.
TaxBit even provides you with personalized information regarding your refund, with information based on the state tax rate, your long term gains, and your short term gains. It looks at federal and state laws, your capital gains and losses, and more, ensuring you have a full view of what you owe and what the government owes you. It does this throughout the year as well, not just when its tax-paying time.
Once your information is in, the platform will generate an IRS 8949 to finish up filing your taxes. If you were trading cryptocurrency years ago, the software even allows you to import previous information, helping you out with back-taxes as well.
The platform’s basic package is only $50 per year, and tracks 250 transactions up from up to 10 exchanges and wallets. That said, if you’re a big-time trader, you may want to opt for the $175/year one, which provides up to 2,500 transactions from an unlimited amount of exchanges and wallets. This plan also includes tax forms from previous years.
Much like CryptoTrader.tax, Koinly is a cryptocurrency tax payment software that’s quite easy to use. Not only does it provide a fiat overlook on top of your return on investment, but the platform even takes into account your cryptocurrency lending, your mining, and your staking, among other forms of cryptocurrency investments.
The platform’s API connects to a variety of different accounts on multiple exchanges, and even allows you to import wallets. If you happen to do margin trading or futures trading, Koinly can even assist you there when it comes to tax reporting. Though keep in mind this type of trading falls under capital gains tax.
Smartly, when importing your information, Koinly even removes transactions that were really just you transferring between wallets or exchanges. This eliminates a tedious step in the process for sure.
Once your tax info is in the system, Koinly will provide you with an 8949 form or a Schedule D. The platform can auto-fill some tax forms for you as well if you’re in the United States.
Like TaxBit, Koinly also allows you to look at your portfolio’s history. It provides graphs and other information while providing you with tips on how to lower your taxes throughout the year. The platform also does a great job of highlighting gaps in your transaction history, if say, an exchange is missing something at the time. That, and it can skip past duplicate transactions as well, so there’s no need to go through and manually do so.
If you’re not sold on Koinly, the platform offers a free trial that allows you to check up to 10,000 transactions from an unlimited number of wallets and exchanges. That said, it won’t generate forms or audit reports for you unless you upgrade to a paid plan.
The $49/per tax year plan allows you to report up to 100 transactions, while the $99 and $179 per year ones allow you 1,000 and 10,000, respectively.